Yantai Dongcheng Pharmaceutical GroupLtd (SZSE:002675) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Yantai Dongcheng Pharmaceutical Group Co.,Ltd. (SZSE:002675) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Yantai Dongcheng Pharmaceutical GroupLtd

How Much Debt Does Yantai Dongcheng Pharmaceutical GroupLtd Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Yantai Dongcheng Pharmaceutical GroupLtd had debt of CN¥933.0m, up from CN¥742.5m in one year. However, it does have CN¥842.4m in cash offsetting this, leading to net debt of about CN¥90.6m.

A Look At Yantai Dongcheng Pharmaceutical GroupLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Yantai Dongcheng Pharmaceutical GroupLtd had liabilities of CN¥1.89b due within 12 months and liabilities of CN¥784.3m due beyond that. Offsetting this, it had CN¥842.4m in cash and CN¥861.4m in receivables that were due within 12 months. So its liabilities total CN¥973.4m more than the combination of its cash and short-term receivables.

Of course, Yantai Dongcheng Pharmaceutical GroupLtd has a market capitalization of CN¥9.65b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Yantai Dongcheng Pharmaceutical GroupLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Yantai Dongcheng Pharmaceutical GroupLtd has a low net debt to EBITDA ratio of only 0.20. And its EBIT covers its interest expense a whopping 10.1 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Yantai Dongcheng Pharmaceutical GroupLtd's saving grace is its low debt levels, because its EBIT has tanked 45% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Yantai Dongcheng Pharmaceutical GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Yantai Dongcheng Pharmaceutical GroupLtd recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Yantai Dongcheng Pharmaceutical GroupLtd's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to handle its debt, based on its EBITDA, is pretty flash. Looking at all this data makes us feel a little cautious about Yantai Dongcheng Pharmaceutical GroupLtd's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Yantai Dongcheng Pharmaceutical GroupLtd .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.